Years of claims by the green lobby that sustainability is good for your wealth have now been supported by independent research.

According to a paper co-authored by Elroy Dimson, a fellow at London Business School, the adoption of a sustainable approach by US companies pushes their share price up by 4.4% over the ensuing 12 months.

Dimson is an independent voice, best known as co-author of annual studies analysing the stock market performance since 1990.

This year, a flood of sustainable products have spread into bonds, real estate and equities.

Crucially, an increasing number of pension schemes and consultants are asking managers for evidence of their engagement skills when they fill in request for proposals, better known as RFPs.

According to data provider Activist Insight, activist funds have returned 2% compared with -4% from the MSCI World index between the start of 2008 and June this year.

About 84% of investors responding to a survey by lawyers Schulte Roth & Zabel expect more activism next year, following poor investment returns and a dearth of takeover activity.

The importance of governance was highlighted by professor John Kay’s report on long-term investing and endorsed by the UK government last month.

Kay’s report said: “The principal role of equity markets in the allocation of capital relates to the oversight of capital allocation within companies rather than the allocation of capital between companies. Promoting good governance and stewardship is therefore a central, rather than an incidental, function of UK equity markets.”

Dimson’s research was co-authored by Oguzhan Karakas of Boston College and Xi Li of Temple University.

Progressive performs

After analysing 2,150 shareholder engagements between 1999 and 2009, it found US companies taking a progressive stance had outperformed by an average of 4.4 percentage points. The gain for all engagements including failures averages out at 1.8%.

This kind of engagement relates to a corporate willingness to adopt environmental, social and governance strategies, or ESGs. But it frequently develops into a focus on the effectiveness of executive decisions, supply chains and risk control, rather than the traditional obsession with profits and dividends.

In the US, engagement generally starts through publicly available proxy filings. European data is more subjective, because engagement tends to take place behind closed doors.

According to Dimson, climate change reform led to excess returns of 10.6 percentage points between 1999 and 2009 as a result of financial gains from energy savings and state subsidies, plus a more positive corporate image. Corporate governance improvements led to an excess return of 7.1 percentage points.

These factors helped US socially responsible funds generate an average return of 3.4% a year against the S&P 500’s 1.1%, according to data provider Morningstar.

During the past five years, US socially responsible funds produced an average 6.8%, compared with 7.2% from the S&P 500. European social funds showed 1.7% compared with 0.7% from the FTSE European index.

F&C Asset Management supplied data to Dimson. Its governance and sustainable investment director Alexis Cheang picks out Apple as one company which performed well with the help of reforms in energy saving and labour practices. She said Occidental Petroleum Corporation performed strongly after introducing performance-related pay for its executives.

Apple and Occidental displayed increasingly sustainable behaviour following their initial reforms, as is often the case after companies start to embrace ESG.

Sarah Wilson, chief executive of proxy-voting agency Manifest, cites food group Unilever as best of breed in the UK. She said: “The academic evidence is compelling, high-sustainability companies achieve more sustainable returns for their owners.

“ESG has often been seen as a separate style, something to be offered as a discrete product, frankly, something of a ghetto. That is changing and more investors are looking for higher-sustainability ratings in their portfolio holdings.”

Kimberly Gladman, director of research at data provider GMI Ratings, said: “Successful engagement may not cause short-term outperformance, but may be correlated with it because both are caused by management quality.”

Dimson’s research confirms that gains by companies made in a single year are sustained over the following six months. He said: “It would be very odd if the one-year performance record were to go into reverse in year two. I would expect the change in value to be more or less permanent, rather than be eliminated after the first year.”

Enlightened benefits

Research by Robert Eccles and George Serafeim of Harvard Business School and Ioannis Ioannou of London Business School argues that companies with an enlightened approach see lasting benefits.
Eccles and Serafeim point out that executive pay becomes aligned with ESG performance.

They said: “Risks and opportunities are identified, the scope of engagement is defined, managers are trained in stakeholder engagement.”

The research said that companies with highly sustainable practices had outperformed those which were less so by 4.8 percentage points a year.

Data published in the Harvard Business Review suggests resource-efficient companies also enjoy an edge over their peers.

GMI Ratings’ AGR index suggests that companies with high-quality governance have outperformed by 4.3% since 1997. It points out this approach has been endorsed by academics at University of California, Los Angeles.

Deutsche Bank has reviewed every single piece of academic research it can find. Mark Fulton, its global head of climate change investment research, said: “Eighty-nine per cent of the studies show that companies with high ratings for ESG exhibit market-based outperformance.”

Deutsche is less impressed with socially responsible funds, saying 88% show neutral or mixed results. But these returns are more encouraging than in the past.

Steve Butler at data provider Camradata points out that growing investor support for ESG should further boost sustainable ratings and help successful engagements.

According to US SIF, a sustainable forum, 11.2% of America’s $33.3 trillion in professionally managed assets now subscribe to ESG principles – a 22% increase in two years.

The Norwegian Government pension outlined support for sterner governance last month, plus action on climate change, water management and children’s rights. It is a top 10 shareholder in 2,400 companies and a thought leader in its sector. The chairman of its strategy council is Dimson.